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Wednesday, October 15, 2003

Should we worry about the fiscal deficit?

Sudhir Mulji, a columnist at the Business Standard, has been arguing for many months that India should not worry about the fiscal deficit. I couldn't agree more. In a developing country like India, output is held in check by the lack of demand. The government should stimulate demand by a massive public works program to build basic infrastructure. The concerns about inflation are, I think, a bit over blown. The productivity growth industry in India and the world has seen in the last few years should be able handle a surge in demand (if we reduce import duties). Besides, a public works program will give jobs to the millions of underemployed poor. With a record foodgrain output forecast and 100bn dollars in RBI vaults, there has never been a better time to think bold. Yesterday Omkar Goswami, Chief Economist, Confederation of Indian Industry wrote something similar in the Financial Express:

On Infrastructure And Deficits

For seven per cent plus growth, is there a case for slightly more deficits to finance infrastructure investments?

OMKAR GOSWAMI

Unlike many Bengalis, Ashok Lahiri, the Chief Economic Advisor at the ministry of finance, is not known for hyperbole. If anything, just the opposite. So, when he, as the government of India's premier economist, informs scribes that India could well attain 8 per cent GDP growth in 2003-04, I had to sit up and read his prognosis very carefully indeed.

Basically, Mr Lahiri's prediction is based on this year's excellent monsoon. Barring very few regions, not only have the rains been plentiful but also there has been no major floods in September. Rainfall data from 1 June to end September 2003 show that it has been by far the best monsoon in the last fifteen years. Typically, good years translate to 80 per cent of the meteorological districts having 'excess' or 'normal' rainfall. This season, 92 per cent of the districts have been so blessed, which is in sharp contrast to the drought of last year.

Given this and the fact that there was a 4 per cent fall in agricultural output last year, Mr Lahiri is betting on something between 9 and 10 per cent growth in agricultural sector income. This isn't overtly optimistic, especially if we consider the smaller base of 2002-03. Since agriculture - more specifically, the primary sector - accounts for 24 per cent of India's GDP, this translates to anything between 2.16 to 2.4 per cent of GDP growth. Add to this an easily attainable 6 per cent growth of industry (which accounts for 26 per cent of our GDP), and an often achieved 8 per cent growth in services (accounting for the remaining 50 per cent of GDP), and you get to Mr Lahiri's estimate of 8 per cent GDP growth in 2003-04.

I am not going to quibble with this number. At worst, Mr Lahiri may be off by half a percentage point. But for an economy that crawled at 4.7 per cent GDP growth in 2002-03, a 7.5 per cent growth in the very next year will be a damn good show. That will make India the second fastest - if not the fastest - growing continental economy in the world.

This brings me to crux of the article: How do we sustain this growth? After all, there is no reason to believe that the rain gods will be as kind next year. So, how can we ensure that India keeps on clocking 7 per cent plus growth over a rising base for the next decade - the kind of growth needed to substantially eradicate poverty and make us a meaningful economic power in Asia and in the world?

The answer: Infrastructure, infrastructure, and even more infrastructure. Let me say it bluntly: You cannot sustain 7 per cent plus growth year on year with the current state of railways, power, ports, airports, IT and telecom backbone, and even roads. It's as simple as that.

To be sure, roads have improved thanks to the Rs 1.5 per litre cess that is financing the work on the Golden Quadrilateral and village roads. I recently drove to Manali, and throughout Kulu district, there were ubiquitous signs proclaiming village roadwork under the Pradhan Mantri Gram Sadak Yojana. There is definite progress. Even so, the 7,200 km North South-East West corridor is still at a nascent stage; and there are 195,231 km of national and state highways, most of which are in pitiable state. We have miles to go before we can claim to have roads like the ones that exist in Thailand, Malaysia or the southern and eastern parts of China.

While roads may be the beginnings of a success story, power is most definitely not. Even last year, there was an average unmet gap of 12 per cent between peak demand and supply. A recent CII-World Bank survey of 1,856 manufacturing companies across 12 states shows that, on average, 9 per cent of the value of production is lost due to power outages. Moreover, 62 per cent of these firms are forced to own generators, which supply, on average, 31 per cent of their electricity needs. In China, production loss due to power cuts is less than 2 per cent; and only 30 per cent of the firms need to own gensets. As far as railways are concerned, the less said the better. And while much is being proclaimed about modernising our airports, one only needs to compare Sahar or Delhi airport with Singapore, or even Bangkok airport, to know how much more we need to do.

Now for some fiscal heresy, which will certainly be frowned upon by Mr Lahiri. Experience of the past decade has shown that there is inadequate private sector appetite for all manner of infrastructure. And yet, without investing in it, we can't sustain 7 per cent plus growth. So, can we marginally increasing the quantum of deficit, provided we can 'ring fence' every additional rupee, and target it for greater infrastructure spending? For instance, it should be possible to convince the Railways minister to levy a flat 5 per cent surcharge on all passenger fares - to be matched by budget support - as a railway development fund. As in roads, this can be used as a fund to modernise Indian Railways and create an integrated supply chain. Similarly, we should be able to allocate a larger amount for development of ports and airports, provided the money is spent on that and nothing else, and spent well.

This strategy won't help all infrastructure. For instance, the power situation requires rapid reform of state electricity boards and a political willingness of chief ministers to raise tariffs to at least cover marginal cost. I am also aware of treading a dangerous path. It's all very well to speak of 'ring fencing'; in reality, there is a serious risk of the additional outlays being siphoned off to feed the insatiable appetite of government consumption. Moreover, increasing the deficit to fund infrastructure assumes managerial and execution skills which are not necessarily in abundance in the bureaucracy.

Even so, I'd say that it is worth a try. We can't sustain over 7 per cent GDP growth without better infrastructure. That isn't going to happen only with private sector participation. It will need dollops of public funding, at least for the next five years. Instead of being fiscal purists and running the risk of choking off future growth, let's experiment with raising the quantum of the Centre's deficit to fund infrastructure to fuel more growth. Let's bet on the denominator (nominal GDP) growing faster than the numerator (the deficit) - which should reduce the deficit as a percentage of GDP. And, as far as managerial talent is concerned, let's get the likes of Narayana Murthy to dedicate their next few years to major infrastructure. For a country of over a billion people, I refuse to believe that there aren't enough managers who can get our infrastructure going.

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Claus and Edward's "Baker's Dozen"

Claus Vistesen and Edward Hugh are proud and happy to announce that they are now working as "featured analysts" with a new Boston-based start-up - Emerginvest.

Claus and Edward have used a new, updated, methodology in order to identify a group of 13 emerging economies which we consider are going to outperform both the rest of the emerging economy group and the OECD economies in terms of a number of key performance indicators over the 2008 - 2020 horizon.

Through our association with Emerginvest we hope to develop performance indicators which will confirm both the relevance and validity of the selection procedure adopted.

We would like to point out that we have absolutely no financial connection whatsoever with Emerginvest - although we do heartily endorse what they are trying to do.

In particular we see the move by the investment community towards emerging markets as one of the most effective and direct ways to address those issues of inter-country wealth and income imbalances which have plagued our planet for so long now - namely by getting the money from the rich who have it to the poor who need it.

Sending investment to emerging economies is also a way of addressing the underlying imbalances which exist between the relatively older populations of the developed economies who increasingly need to save, and the relatively younger emerging economies who can benefit from the investment of those savings in their countries. So in a way you can both ensure the future of your own pension and help attack poverty at one and the same time. This type of possibility is normally known in economics as "win-win".

The oldest known source and most probable origin for the expression "baker's dozen" dates to the 13th century in one of the earliest English statutes, instituted during the reign of Henry III (r. 1216-1272), called the Assize of Bread and Ale. Bakers who were found to have shortchanged customers could be liable to severe punishment. To guard against the punishment of losing a hand to an axe, a baker would give 13 for the price of 12, to be certain of not being known as a cheat. Specifically, the practice of baking 13 items for an intended dozen was to prevent "short measure", on the basis that one of the 13 could be lost, eaten, burnt or ruined in some way, leaving the baker with the original dozen.

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About Claus

Claus Vistesen is a 23 year old macroeconomist who is on the point of finishing his MSc in Applied Economics and Finance from the Copenhagen Business School. His primary research interests are international finance and international macroeconomics. Claus is especially interested in how the changing structure of global and national demographics impacts on local macroeconomic performance. Moreover - and as the wonk he ultimately is - he also takes a considerable interest issues and methodologies associated with econometrics, and this is an interest he intends to develop in his postgraduate research.

About Edward

Edward 'the bonobo' is a Catalan macroeconomist and economic demographer of British extraction, now based in Barcelona. By inclination he is a macroeconomist, but his deep-seated obsession with trying to understand the economic impact of contemporary demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

He is currently working on a book with the provisional working title "Population, the Ultimate Non-renewable Resource".